Here are some characteristics of two securities: Security 1: = 0.1 = 0.0025 Security 2: = 0.16 = 0.0064
Answer the following questions:
(a) Which security should an investor choose if she wants to (i) maximize expected returns, (ii) minimize risk (assume the investor cannot form a portfolio)?
(b) Suppose the correlation of returns on the two securities is +1.0, what is the optimal combination of securities 1 and 2 that should be held by the investor whose objective is to minimize risk (assume short sales are not allowed)?
(c) Suppose the correlation of returns is -1.0, what fraction of the investor's net worth should be held in security 1 and in security 2 in order to produce a zero-risk portfolio?
(d) What is the expected return on the portfolio in (c)? How does this compare with the riskless return on Treasury Bills of 10%? Would the investor want to invest in Treasury Bills?